Saturday, January 10, 2015

Saudi Arabia’s Cure for Shale Could Entail Shock Therapy - Oil Futures May Continue to Slump in Price War

For many oil-exporting countries, though, the more important price is the one it takes to cover swollen public budgets. In the wake of the Arab Spring, this isn’t just an economic consideration. So while in strictly operational terms it might cost less than $20 a barrel to extract oil in Saudi Arabia, the “fiscal break-even” price is estimated to be around $90 to $100.

But that is only half the equation. The other half is volume: If you are getting less money per barrel, one way of trying to cover your costs is to produce more barrels, if you can. There is a trade-off because the more barrels on the market, the lower oil prices go—at least until some producers needing even higher prices are forced out.

The U.S. shale boom’s potential Achilles’ heel is its reliance on easy credit. Crashing oil prices would both cut the cash flows needed to pay interest costs and reduce the value of reserves that exploration and production firms use as collateral for new loans. A rapid drop in price also would complicate the E&P industry’s ability to adapt via redeployment of resources to more productive fields or selling assets to better-capitalized oil majors.

Saudi Arabia appears to have gone for the nuclear option in maintaining its output. But maybe you ain’t seen nothing yet.